Beneficiaries have options for their inheritances

Most of my writing focuses on the state of the economy and what some of the impacts may be of the events that are happening around us. Today, however, I thought it would be a good idea to write about an idea that may help some people take a proactive approach in planning to pass assets on to their loved ones in the most efficient way possible.

Comment

poconorecord.com

Writer

Posted Sep. 9, 2012 at 12:01 AM

Posted Sep. 9, 2012 at 12:01 AM

» Social News

Most of my writing focuses on the state of the economy and what some of the impacts may be of the events that are happening around us. Today, however, I thought it would be a good idea to write about an idea that may help some people take a proactive approach in planning to pass assets on to their loved ones in the most efficient way possible.

Of course, any planning should be done with your advisers including attorney and CPA.

Most assets can be passed by will or in a trust to your beneficiaries. In most cases, with the help of a competent attorney you potentially will be able to pass on more assets free of federal taxes and possibly state taxes by planning for the distribution before your demise.

One asset that has historically been a problem is if someone does not have a spouse and they have a 401(k) retirement account. That asset then passes to a named beneficiary. The problem with that is that the entire amount is added to the beneficiary's income for that year and can create a large taxable event.

Let's say you have an uncle that passes away and has $500,000 in a 401(k). Traditionally, that $500,000 would go to the beneficiary — let's say nephew John. John has an income of $35,000 and is single. That $500,000 would be added to nephew John's income for that year and it would push him into the maximum tax bracket. The IRS would potentially take over $151,000 in tax. (2012 IRS tax guide)

In recent years there has been legislation that allows for "stretch IRAs" which allow beneficiaries of IRAs to defer the lump sum tax and pay as you go so that you may not get pushed into higher tax brackets. When I say "pay as you go" I mean that a minimum distribution still must be taken annually from the IRA according to IRS rules. This allows you to determine what you would like to take out and gives you control over when the tax is paid as long as you take out the minimum mandatory amount the IRS mandates.

As a beneficiary of a 401(k), you actually have the same opportunity to have a "stretch IRA" but there are several steps that you have to take to make sure that the IRS will approve of the plan.

First, there has to be an account set up that can receive the distribution from Uncle's 401(k). It is important to note that this has to be a new account and hold only assets from uncle's 401(k).

Second, the 401(k) trustee has to transfer the funds directly into this account. If uncle was older then a required withdrawal may have to be taken before the transfer can take place.

Third, you cannot forget that even though the beneficiary may be younger than 70.5 there is still a required minimum distribution to be done every year.

This plan really allows for maximum flexibility. If you have a year where your earnings are weaker you could take more money out. That would not only help you get by in a lean year but also would allow you to possibly keep your taxes in a lower bracket.

The main point to remember here is that it would be very helpful for a generous relative to have a chat with the beneficiary and let them know that an account should be set up if this is the route that they choose to take. Of course, there may be circumstances where taking the lump sum and paying the taxes make sense — like starting a business or paying off debt.

In any case, it is important that the beneficiary is aware of all the options and not just the one where they may actually collect the least because of taxation that can be legally postponed.

Mike Savage is financial adviser and president of Savage Financial Group in East Stroudsburg, which offers securities through Raymond James Financial Services.